Monday, February 18, 2008

Interview with Brad Humphreys

A week and a half ago, I approached Brad Humphreys about the possibility of doing an interview with The Battle of Alberta. Professor Humphreys kindly agreed, and below is a transcription of our email exchange. Professor Humphreys is currently an associate professor of economics, and Chair in the Economics of Gaming, at the University of Alberta. Before coming to the UofA, Humphreys was an associate professor at the University of Illinois Urbana-Champaign, as well as the University of Maryland Baltimore County. In addition to his many academic works on the economics of sports, Humphreys is a regular poster on the excellent blog, The Sports Economist (baseball fans might also enjoy an interview Humphreys did with Keith Law for Baseball Prospectus, especially in light of the recent news that Miami-Dade County will be paying the lions share of a new stadium for the Florida Marlins).

On to the Q&A...

What made you decide to move to Edmonton, and work at the University of Alberta?

The University of Alberta is a great university; the economics department is very strong and has a PhD program and I am very interested in working with graduate students. It’s a fantastic opportunity to work in a great research shop. I prefer urban living and Edmonton is a very livable city with a lot of great amenities.

What projects--academic or otherwise--are you working on at the moment?

I am working on several projects related to the economics of sports facilities. A graduate student and I are analyzing the effect of sports facilities on nearby residential property values. Another other grad student and I are investigating the effect of new facilities on attendance in junior hockey leagues. I am finishing up a book, The Business of Sport, which I am editing with Dennis Howard of the University of Oregon. It is three edited volumes of essays on various aspects of the sports business, written by academics and industry professionals. It will be published in June. I am also working on several research projects related to the economics of gaming and sports betting.

What was it like testifying in front of the U.S. Congress last year? Why did they call you?

I was called to testify on the New York Yankee PILOT (payment in lieu of taxes) decision. The U.S. Internal Revenue Service ruled that the New York Yankees could issue tax exempt bonds to finance the construction of their new stadium. In 1986, Congress explicitly outlawed the use of tax exempt bonds to finance sports facility construction under certain conditions, which would usually apply to the new Yankee Stadium. The IRS ruling circumvents this, based on the claim that the project warranted the use of tax exempt bonds because of the economic impact that the stadium would allegedly generate. I was asked to testify about the lack of evidence supporting the assertion that a sports facility generates positive economic impact.

The hearing was a lot of fun. I testified with a friend and former colleague, Dennis Zimmerman, who is probably the leading expert in the world on bond financing for professional sports facilities. I hadn’t seen Dennis for several years, and he’s a really interesting guy. I went at it a bit with a congressman from Southern California during the question period, which was an interesting experience. I was testifying before Dennis Kucinich’s House sub-committee, and I got to talk with him a bit. An interesting experience, all-in-all.

You had a chance to be a participant at the “Role of Sports and Entertainment Facilities in Urban Development” conference hosted by the Edmonton Chamber of Commerce and University of Alberta on February 12th. For those who were unable to attend, could you share with us the ideas/arguments you presented at the conference, as well as any other thoughts you have on the conference as a whole?

I summarized my published research, and some research by other economists, on the economic impact of professional sports in the local economy in my presentation. I have gone back and looked at the economic performance of cities, in terms of income per capita, employment and wages, since 1969 looking for evidence that professional sports generate tangible economic benefits. Over this long period of time, there has been a lot of facility construction and renovation, expansion, and franchise movement. These changes provide variation in the quantity and quality of professional sports in cities over time, and I have looked for statistical evidence that changes in the “sports environment” in cities explains any of the observed variation in economic indicators over time.

The short answer is: they have not. Attracting teams and building bigger or newer facilities was not associated with economic growth, or changes in the levels of any of these economic indicators. Professional sports are not, and have never been, engines of economic growth in North American cities. They are effective at moving consumer’s entertainment from one part of the city to another, and raising employment and wages in one specific sector of the local economy, the Recreation and Amusements sector, which contains professional sports teams.

People interested in providing government subsidies to sports teams – team owners, real estate developers, elected officials, and others who will benefit directly from these subsidies – loudly and consistently claim that large, important economic benefits flow from professional sports. Their evidence takes the form of (1) unsupported assertions (“of course these benefits exist!”) coupled with ad hominem attacks on opponents (“only an idiot, or an economist, would believe that sports aren’t great for the local economy”) or (2) Economic Impact Studies that are really promotional forecasts based on badly flawed methodology.

My research does not mean that subsidies for new hockey arenas are bad. Sports clearly produce important intangible benefits in cities, which may justify government subsidies. My research just means that we – taxpayers, elected officials, team owners, and other stakeholders – should decide on subsidies based on these intangible benefits, not on overblown claims of economic benefits (“More jobs! Higher income!”) made by a few people who will benefit immensely from the subsidies.

I thought that the conference was very well put together and informative. This is a complex issue, and all sides were represented and allowed to make their case. Dan Mason put a lot of hard work into the conference, and was instrumental in getting a lot of prominent speakers from all over North America.

What is your take on the proposed downtown arena discussion so far? Does a new arena for the Oilers benefit the city of Edmonton, or just the owner(s) of the team? Or is this either/or dichotomy too simplistic? Will a downtown arena be beneficial to both the city and team?

A lot of people will benefit from a new arena; most of the benefits will be intangible. Oilers fans who go to games will benefit because they’ll have a much nicer facility, and it will have many more amenities than Rexall. Edmontonians who attend non-hockey events at the arena will benefit from having a nicer facility as well. Edmontonians will also benefit to the extent that a new arena increases civic pride and makes them feel like they live in a “world class city” if you buy that particular story, and from having more entertainment choices in town. Fans who don’t attend games will get some satisfaction knowing that their team plays in a state-of-the-art facility. Local businesses who want upgraded luxury seats and premium seating will benefit from having access to these. The team owner will benefit because the new arena will be a cash cow and generate much more revenues than Rexall. The owner of the Oilers will get most of the financial benefit from a new arena. The mayor will benefit because he’ll look like an effective politician. Property owners near the new arena will benefit from higher property values. The city will benefit from these higher property values, because property tax revenues will be higher.

Fans who expect that the team will be better may be disappointed, as there is little evidence that new sports facilities lead to prolonged success.

After observing many, many sports facility deals in many cities, my “take” is that in Edmonton, like everywhere else, interest group politics will dominate the wishes of the taxpaying electorate. If powerful local interest groups want a new arena paid for with taxpayers dollars, it will happen. Mancur Olson provided the economic basis for these sort of outcomes over 25 years ago, in The Logic of Collective Action.

Have you had, or been asked to participate in, any discussions with the City of Edmonton’s Arena Feasibility Committee? If so, can you give any insight into the sort of questions the committee had, and what answers you were able to provide them with?

I was not asked to participate in any of the Committees that were formed to look at this issue. I didn’t move to Edmonton until August, and I think the committees were formed before then. I have not been asked to provide any input to these committees.

Should Calgary Flames fans care about this issue?

Yes, because, like it or not, if the Province subsidizes the construction of a new arena in Edmonton, they will be paying for it too. Government dollars are fungible, and $100 million of Provincial money spent in Edmonton is $100 million not spent somewhere else.

One of the arguments being made by proponents of a downtown arena is that an arena as part of a bigger downtown development project is the way to go. They argue that while an arena by itself doesn’t provide any economic benefit to the city, an arena along with entertainment, commercial and/or residential properties will stimulate economic growth, and lead to a “revitalized” downtown core. Arena projects in Columbus, San Diego and Indianapolis have been used as examples. What are your thoughts on this idea, and these projects? Is the idea of a hockey arena as an “anchor” site for broader development one that makes economic sense?

This is a bit outside my area of expertise. I have walked around the arena in Columbus and the stadium in San Diego. A lot of development clearly took place there. I also understand that the developers in each case were given wide-ranging powers by the local government in each case to make this happen.

I am somewhat leery of simply looking at the best-case-scenarios from other cities and concluding: “it happened there, it will happen here.” 29 new arenas and stadiums have opened in North America since 2000. Columbus and San Diego are probably the most wildly successful. The others are less successful, some much less successful, in terms of revitalizing the surrounding area. For example, the new football and baseball stadiums in Cincinnati and Pittsburgh, four facilities, have had very little impact on the surrounding areas. It is possible to have a profound effect on the surrounding community, but it is far from certain that this will happen.

To date, soon-to-be-owner Daryl Katz has pledged $100 million dollars towards the building of a new downtown facility. Yet the arena and the surrounding development is expected to cost substantially more than this. Where, in your mind, is the difference going to come from? Is there a way to finance the building that doesn’t involve some kind of public funding, short of Mr. Katz paying for the whole project himself?

If Katz can’t come up with enough money to bankroll the whole project, then there are two other sources of funding: government subsidies and other sources of private funding. Although government funding is the most common alternative source, there are plenty of recent examples for alternative private funding. For example, when the Blue Jackets’ ownership group could not privately finance the new arena, Nationwide Insurance stepped in and financed the rest privately in exchange for naming rights and other incentives. There is no reason to think that the same thing can’t happen here.

In a recent article in the Philadelphia Enquirer, sociology professor Rick Eckstein noted that the mainstream media “is noticeably biased toward supporting publicly financed stadiums, which has a significant impact on the initiatives' success.” You have been studying these debates for a long time now. Does Eckstein’s statement align with what you have seen and heard?

Absolutely. Eckstein, and his collaborator Kevin Delaney, have been exploring this idea for several years now. I have not read the book yet, but I vividly recall reading their related article “The Devil is in the Details: Neutralizing Critical Studies of Publicly Subsidized Stadiums” that was published a few years ago and having an “a Ha!” moment. It’s a very good explanation for why the general public doesn’t pay attention to research in this area. I have seen this play out many times in many cities; the local media is almost always strongly in favor of government subsidies for sports facility construction. In addition to the Delaney & Eckstein explanation, sports coverage helps newspapers’ sales and local television stations’ ratings. These media outlets have a vested interest in keeping pro sports heavily subsidized and happy because it contributes to their bottom lines.

And finally, Seattle Super Sonics ownership recently flip-flopped on the economic benefit their sports team will provide to the city because they want to get out of their current arena lease. Is it true, as your colleague Dennis Coates notes, that the Sonics hired you as an expert? If so, what did that feel like, having a professional sports team utilizing your findings to their benefit, rather than ignoring them or brushing them aside? That must have been surreal.

In order to break their lease, the Sonics have to prove that the local economy will not be damaged as a result of their departure. I have studied the effects of franchise departure on the local economy and published a number of papers in peer reviewed academic journals on this topic. My position has been consistent on the issue: professional sports do not generate tangible economic benefits in the local economy. Even the Edmonton Journal got the point last week. This research has a number of applications that are of interest to many different groups. To date, it has primarily been of interest to local grass roots organizations opposed to sports facility development projects. I have accepted compensation, in the form of travel expenses, from these groups. Beyond this, I can’t comment on pending litigation that I could potentially have a role in.

In addition to answering my questions, Brad has volunteered to answer any questions that our readers might have about the proposed downtown arena. I hope that all of you can take advantage of this, no matter what side of the issue you are currently on. Please ask your questions in the comments section. Brad will drop in every once in a while to answer what he can. Please keep things civil, at least with Brad. We can fight amongst ourselves, if that's what's required. :)

The transcript has been formatted for this blog, and a couple grammatical changes were made. Any errors in spelling or grammar are mine.

On behalf of Matt and myself, many thanks to Brad Humphreys for doing this Q&A with The Battle of Alberta. It was, and is, greatly appreciated. Have a great Family Day, everyone.

Great interview Andy. I'm surprised at how closely I've followed your coverage of this, as someone whose only connection to Edmonton is as an oilers fan. You've done a great job of keeping on top of the media through all of this. It's been very enlightening.

My kudos to Andy as well, and I do have a question -- I'm interested in the broader context of the statement, "Professional sports are not, and have never been, engines of economic growth in North American cities."

Growth happens; the economy expands. I am *not* trained in economics, but my general understanding is that growth results essentially from people providing something that other people want for a price they like. What *are* the engines of economic growth in North American cities? Why don't pro sports grow the economy in the same fashion as other services and industries? If the pro sports industry only "grows" at the direct expense of other industries, in a zero-sum fashion, who suffers?

Or am I misunderstanding, and it's actually the govt taxes & spending that cancel out what would otherwise be a regular ol' engine of growth if it were privately financed?

The factors that determine long run economic growth in North American cities are growth in the productivity of workers (measured by output per worker), in migration of labor, and increases in the capital stock.

"If the pro sports industry only "grows" at the direct expense of other industries, in a zero-sum fashion, who suffers?"

Other entertainment industry businesses located around the metropolitan area. Bars in the suburbs, movie theatres, bowling alleys. These establishments lose revenues when people go to a hockey game, because consumers have a fixed budget.

"I think I might guess the answer, but does Brad have any thoughts on a stadium location in a city, ie. downtown vs. the suburbs, and how that affects the economics?"

Dan -

A downtown arena is more likely to generate spillover benefits, primarily increased property values around the arena, than a suburban arena. But in my research that looks for tangible economic benefits of sports facilities, location made no difference.

"If the pro sports industry only "grows" at the direct expense of other industries, in a zero-sum fashion, who suffers?"

Other entertainment industry businesses located around the metropolitan area. Bars in the suburbs, movie theatres, bowling alleys. These establishments lose revenues when people go to a hockey game, because consumers have a fixed budget.

Pardon my thickness, I suppose, but I'm not satisfied by this answer. I thought that building bars, movie theatres, and bowling alleys -- in aggregate and over time -- contribute to economic growth. Is that wrong? Are "entertainment industry businesses" as a whole not contributors to economic growth?

If they are, why is pro sports unique in simply drawing revenue from its entertainment competitors rather that contributing to growth? And if not, why is the whole industry different than other industries? (Are there other industries that are non-factors in growth, and what characterizes them?)

I have two questions, and they both arise from the following statement:

”Property owners near the new arena will benefit from higher property values. The city will benefit from these higher property values, because property tax revenues will be higher.”

The first statement surprised me, because my perception is that the areas around many stadiums (including Rexall) look run down and economically depressed. Whether it’s the effect of transportation corridors, the parking lot dead-zone, or the nuisance impacts from events, haven’t many arenas had a negative effect on nearby property values?

The second statement confused me, because I’m not sure how higher property values in any one part of town increase aggregate property tax revenue. Market Value Assessments play no role in determining how much revenue to collect (that’s set separately). Instead, the MVA is used to determine how the pie will be divided among property owners. If an arena increases neighbouring property values then that will change the distribution of taxes between properties – properties that have higher than average value growth will also see their taxes go up faster than average. But the total amount of tax collected stays the same.

My statement about property values is based on some unpublished research of mine, and a couple of published papers. It's based on data from a large number of sports facilities in the US, as well as a case study from two facilities in Columbus, Ohio.

I am not familiar with how property taxes work in Alberta, other than how to pay them ;-). However, in most US cities, the process does not work like the one you have described. In most US cities, higher assessed values will lead to higher property tax revenues. maybe someone familiar with both systems can chime in and set me straight.

Wow... How remarkable.. Andy, who claimed to be too busy, too broke, too whatever to go to the conference yet was so fortunate to find time in his busy schedule to find the one in eight that matched his views for an interview. Please Andy, Pravda was not so blatant. Your questioning was juvenile ,self serving and at about a grade eleven social studies level. Andy get a life , move on from your parents basement, shut off the video games and try to actually do something to add som miniscule value to Edmonton. Then get a job, contribute to society and quit being such a knob. Why did you not try to call the other seven? Or perhaps you did and couldn't find one to support your negativity. If all of Edmonton was like you we would be a prairie backwater. Not sure what you do or contribute to Edmonton but I suspect it is a thousand times less than you take.

I think I might guess the answer, but does Brad have any thoughts on a stadium location in a city, ie. downtown vs. the suburbs, and how that affects the economics?

This question seems to be part of a much larger issue.

Personally, I think a city with a vibrant downtown core is inherently more valuable than cities with strong suburbs and desolate downtowns like say Atlanta. Or even Detroit at the extreme.

Are there tangible benefits there or are these just intangibles as well?

On a more Edmonton related note... Does anyone consider the Northlands area a suburb really? I wouldn't term it as such because it's really not that far away from downtown and linked by the LRT. Just my opinion, but this debate should never boil down to suburb vs. downtown.

First off, it should be asked whether we even need a new arena. Then the question is Northlands vs. downtown. There should be no Phoenix options considered IMO. (America West vs. Glendale) And of course, efforts to paint it otherwise should harshly ridiculed in a wholly anonymous fashion. (silly pseudonyms are exempt)

I would say probably no, if we assume that the cap and other costs to run a team will be about the same level 8 or 10 years from now as they are today. Although you might want to ask Kevin Lowe about that one.

I have to say that I was a bit dismayed in this interview. I think we've beat to death the idea that an arena alone being subsidized by public funding is a bad idea. One that I agree with by the way. So despite Professor Humphreys excellent responses, my first reaction was "duh".

However, the only real strategy that seems to make any sense in this case is one of using the arena as an anchor tenant for a larger concept. There has been evidence to support this, so I was really looking forward to hearing some thoughts on that scenario.

Did the successful examples that Professor Humphreys cited turn out that way because of diligent planning? And even if they didn't and it was a fluke, couldn't we learn something from those cases? Despite the shitty end to the Dell deal, the city now has a fully developed property that has tenants ringing the city's phones off the hook to rent. I'd be OK with concessions to get that part of town redeveloped, because quite frankly, its a shithole right now.

Is it not at least plausible that an owner with the obvious financial acumen as Mr Katz could access the necessary funding on his own? Its been mentioned more than once (yeah OK, in the MSM) that a project of this nature would be eminently viable through private means.

I know I'm going to sound like a dick for asking this (especially given that Andy obviously did a great job putting this piece together), but given the assumptions that have been made to support his argument, I have to ask.

Andy, do you or do you not have any hard evidence to support your assumption that the arena project is going to be funded as you assert? If so, please share this evidence with us because I'll gladly recant anything I have said over the last while. And no, "anybody can tell" and "its obvious" won't do this time.

The reason I ask this is because while you do have a plausible point of view, you have not given any benefit of doubt to any other possible outcome.

Andy, do you or do you not have any hard evidence to support your assumption that the arena project is going to be funded as you assert? If so, please share this evidence with us because I'll gladly recant anything I have said over the last while. And no, "anybody can tell" and "its obvious" won't do this time.

Look, it's obvious that Andy's position is based on an assumption that there's going to be some sort of public funding involved. Quite frankly, I don't know what other assumption would be reasonable and I think that that's the real question that people should be asking. If your position is wait and see, that's fine, but given the assumptions that Andy is making, his position is utterly reasonable.

Katz says that the mayor told him a $100MM contribution would be necessary, we know that arenas cost more than $100MM...where else is the money going to come from? I mean, if you have a more reasonable assumption that Andy should be making, by all means, throw it out there but the faith in the arena fairy in Edmonton seems to be unusually strong.

if you have a more reasonable assumption that Andy should be making, by all means, throw it out there

Just to play devil's advocate, don't municipalities usually have access to lower intrest borrowing rates than individuals? Maybe it would make financial sense to have the city borrow the rest and Rexall Sports (and Northlands?) pay back the city the amount of the loan (and say half the difference between the cost of borrowing for the city and the cost for Katz).

I'm not suggesting that this is the plan, or even that it's a more reasonable assumption (and frankly I'm not even sure if it would be legal option), but I thoguht I'd throw it out there. I'm also not really sure why the city would agree to something like that, other than it's better than just writing a cheque. Maybe Prof. Humphreys knows whether this type of funding model has ever been used elsewhere for an arena?

On the property tax question, I think Avi is mainly right. Cities decide on how much revenue they need to raise, then they apply the appropriate mill rate to the total market value assessment. So an arena development by itself will not necessarily generate any more property tax revenues.

However, if an arena development increased the total market value assessment in the city then that would increase the city's revenue raising capacity. The city could raise a little more property tax revenue while keeping everyone else's rates the same. They could also raise the same amount of revenue while lowering property taxes for everyone else (ha!).

Governments can issue bonds with a lower coupon rate because (at least in the US), the interest payments are exempt from taxation. This is implicitly a subsidy from all taxpayers to the beneficiaries of the bonds. In this case, all Canadians (if the bond interest is exempt from Federal tax) or all Albertans (if exempt from Provincial tax) would be subsidizing the team and fans of the Oilers.

David S writes "I think we've beat to death the idea that an arena alone being subsidized by public funding is a bad idea."

From my perspective, this is not so clearcut. In most places, I find it very difficult to get my research, and it's implications, disseminated broadly. The typical media coverage would be something like 90% focused on positive tangible economic benefits, 10% on the evidence from academic research.

Thanks for the clarification on the lending rates. I'm not suggesting that that's something the city should do, just suggesting that that might be what Mandel has in mind when he tells Katz he'll need 100M up front and he tells everyone else that city money won't be used. It would deffer the subsidy to the other levels of government and would still allow him to claim that the arena is being fully paid for by the Oilers (and other users).

Yes, because, like it or not, if the Province subsidizes the construction of a new arena in Edmonton, they will be paying for it too. Government dollars are fungible, and $100 million of Provincial money spent in Edmonton is $100 million not spent somewhere else.

I would add to this that, like jealous siblings, what Edmonton gets, Calgary wants, and vice versa. There's been very low-level rumblings about whether or not to replace the Saddledome, despite its relative youth (25 years this fall), capacity (19,289; I don't know the luxury-box count offhand), and architectural uniqueness, not to mention renovations made to improve the facility back in 1994. I can't fathom why they'd want to do that, but there we go.

I'm not a Flames fan at all, but I do live in Calgary, so such a development would obviously have both tangible and intangible impacts on me.

In politcalese, when a Mayor says that public money won't go into building an arena, it doesn't mean that public money won't go into everything around it, whether its infrastructure costs or tax breaks.

For those wondering why Andy assume that tax money will be spent on this only have to be reminded of the sweetheart, heavily-subsidized Northlands deal the Oilers already have with the City.

Not to mention Mandel's slobbering enthusiasm for this project from Day 1.

Well done, Andy and Prof Humphreys. It would be naive to assume the new arena will be built strictly with private money. After my letter to city council opposing welfare to millionaire hockey players and drugstore owners, the executive assistant of Ward 3 responded, saying her alderthingies had heard and read "overwhelming opposition" to the idea. So I guess Andy's not the only one who refuses to leave anything to chance. Again, well done.

Dr. Humphreys, it's already been answered, but property taxes in Alberta are raised based on budgetary needs. It's opposite of the U.S. system, where rising assessments in and of themselves raise government revenues. It's one of the things that I love about living here.

Canadian municipalities don't issue debt, and federal/provincial bond interest is not tax exempt, two more things I love about living here. However, there is a cost-of-capital arbitrage between the province's and the private entity's borrowings for taking on the same project, but this is harder to explain in the mainstream media.

I have a questions about financing in general. To what extent do municipalities offer direct funding as opposed to guarantees? Do U.S. municipalities have to provide direct funding in order to expropriate land? Are bond issues supported with additional tax revenue from facilities themselves, or from spinoff benefits (ie, do facilities "repay" municipal investment through property tax, or not?) Are these even the right questions to be asking? Basically, I'm interested in how stadium deals are typically financed, and especially how the non-financial terms cede risk to the municipalities in the event that everything goes brown.

Finally, do aspirational cities (San Diego, Phoenix) tend to spend more on stadium subsidies, or is it the poorest cities (Pittsburgh, Buffalo, New Orleans, Cleveland?). I assume that the truly world-class cities (LA, NYC, Chicago) don't spend much on subsidies; is this true?

From macndub: "Canadian municipalities don't issue debt"Alberta municipalities have access to debt through the Alberta Capital Finance Authority. The amount that can be borrowed is limited by formulas (Edmonton has a lot of cap room). To the earlier question of whether it's a cheaper cost of capital than private sector borrowing, it is, although not by much if the private borrower is investment grade. ACFA's 30-year rate is currently 4.729%.

On the type of cities that subsidize teams, I'll leave it to Brad to answer. But big cities like NYC are just as susceptible. In New York, City Council recently voted 40 to 3 to end the $12 million property tax exemption Cablevision receives for Madison Square Garden. However, they can't wriggle out without tough to win state approval.

And to DavidS's point that I think we've beat to death the idea that an arena alone being subsidized by public funding is a bad idea.

I agree with Tyler's reply, and want to add to it a bit. The three strongest pieces of evidence that there will be a proposal for public funding are: (a) the math, which is really a logic proof; (b) the weasel words being used to reject the idea, which make me suspicious, and (c) the long history of creative deals, including the original EIG deal which involved a direct cash transfer of $4.6 million a year (ticket surcharge and net cost of the facility); incurring an opportunity cost from the foregone revenues associated with naming rights, parking, concessions and market-rent; and a property tax exemption achieved by keeping the building under third-party ownership.

And what do we see when we look around the city? How about a $240 million interchange being built at South Edmonton Common, which really amounts to a subsidy to the mall's property developers. The oversized infrastructure isn't being funded by the developer. Did that require the City to hand the developer a cheque for $240 million? Nope. It 'just' had to build the related infrastructure. It's the same with the new Yankee Stadium -- the government is funding $200 million of related infrastructure (mostly parking and transit facilities) and letting the Yankees access tax-exempt bonds for their own debt capital. But are they using public money to pay for a stadium? Nope.

And last, a word for anonymous, who thinks that If all of Edmonton was like [Andy] we would be a prairie backwater. I'd suggest that if all of Edmonton was as facile as anonymous, we'd already be riding a monorail.

As a Flames fan, of course I'm going to assume (and demand) that Calgary is also going to get an equal amount of cake to whatever Edmonton gets. BUT I suggest Calgary invest this money in the University's Economics department, which I'm pretty sure will be a net economic driver for the city.

PS. We could also offer a RFA contract to Professor Humphreys to resign with the U of C.

Avi, can Alberta municipalities borrow in the public markets, as U.S. cities do? I thought that they couldn't... ACFA seems like a wrapper that allows munis to borrow at the provincial bond rate, essentially from the province.

To the earlier question of whether it's a cheaper cost of capital than private sector borrowing, it is, although not by much if the private borrower is investment grade. ACFA's 30-year rate is currently 4.729%.

Cost of capital is associated with projects, not project proponents. The combined (debt and equity) return that an entertainment project should demand is probably in the 10% range (Prof Humphreys?). To the extent that the city can borrow at 5%, while the market interest rate for that project risk is 6% or higher, it represents a significant arbitrage for the project developer. An investment grade borrower using its debt capacity to finance a stadium is cross-subsidizing risk and probably won't be investment grade for too much longer.

BAA credit spreads are north of 3% right now; historical highs, but the States is in the midst of a credit crunch right now....

The City Auditor's 2006 report covers the municipal debt question at page 16:

"The City of Edmonton utilizes two types of debentures: private issues and public issues. Private issues are debentures primarily issued to the Alberta Capital Financing Association (ACFA), the Receiver General for Canada, the Provincial Government of Alberta, or the Canada Mortgage and Housing Corporation. Private issue debentures are issued or sold, under the direction of the City Treasurer, as authorized by City Council. Authority to pass debenture bylaws for capital borrowing comes from the Municipal Government Act. Public issues are City of Edmonton debentures which have been issued and sold to the public. As with private issues, the proceeds from the public issue debentures have been used to pay for the construction of capital projects...The City of Edmonton last issued public debentures in 1993 and those debentures will mature on September 14, 2018."

On the question of benefiting from the difference between ACFA and market rates for borrowing, the difference shouldn't be material. On a $300M project with a 50:50 debt/equity structure a difference of 2% would amount to $3M a year. Great if you can get it, but it's not going to be the difference between a go/no go.

The present value of a $3 million perpetuity, after tax, is about $20 million. On a $300 million stadium deal, that's a pretty significant chunk of the valuation, and could well make the difference between a go/no-go decision.

The present value of a $3 million perpetuity, after tax, is about $20 million. On a $300 million stadium deal, that's a pretty significant chunk of the valuation, and could well make the difference between a go/no-go decision.

Just the present value of money, Andy, and macndub has a fair point. I'd put the present value of a 1% spread in the interest rate over 40 years around $24 M (using a 4.5% discount on the difference in cashflows, based on mortgage financing rather than an annuity), although it's only in the first ten years that the difference is Convincing the City to pass through a lower cost of debt is a great example of government support that's not quite the same as the City paying for an arena. It does put the taxpayer at risk, but everyone's assumption would be that the risk won't materialize. A dangerous assumption to make over a 40-year timeframe, during which Katz may not be the only owner.

The only other issue I can think of (other than the principle of the thing) is that it uses up municipal borrowing capacity -- but the City's position over the past decade has been that it didn't want to use that capacity (a view that's slowly changing as people perceive an infrastructure deficit).

There'd be a good post in simply listing all the creative ways we can think of that the arena could get public support without it being a blatant pay-for-the-arena investment. Top of mind for me:- The LRT station/extension and traffic tie-ins;- a landswap with Canada Post so they have a new site to move to;- building the parking (especially if non-event parking revenues go to the City);- involving Northlands in the deal in order to avoid property taxes, and continuing to cover Northlands net operating costs (i.e. charge a below market rent) while passing through the benefits from naming rights (and could Northlands build the arena accessing ACFA financing?).

I could easily see the above exceeding $100M without counting the multi-year cash from parking, concessions, etc.

Another way to look at it is that the payments on $200M at ACFA rates are a little more than $11M per year, while the City's tax-supported operating budget is nearly $1.5 billion. I'm sure there's room for it somewhere.

Sorry. I'm not really an asshole, just devolve into shorthand when I'm sneaking blogs in at work.

The only thing that financial analysts do in this world is try to normalize cash flow. Cash is convenient, but doesn't always show up when you want it. It also might not show up at all. So, before attempting any investment, a spreadsheet monkey has to calculate the present value (bring all the cash flow back to a single point in time--today), and risk adjust it.

I assume you know this; I'm just framing the conversation.

The taxman takes his share before anyone else, so only after tax cash flow makes sense. The remaining cash from an investment is split to the investors: traditionally, debt and equity. Cash flow to bondholders (debt) is stable and low risk as they get the first crack, then equity (higher risk) follows. How this risk gets allocated is through the discount rate that you use to present value the cash flow.

So, say you have an investment that you think should return 10% a year. If that investment is financed 50% through debt, and 50% through equity, and some banker will loan you the debt at 5% interest, then you can impute a 15% equity rate of return on your project. A sweet deal, right?

Wrong.

Because the additional leverage actually increases the risk that you, as equity, won't get your cash, you have to apply a higher discount rate to obtain the present value. That discount rate just happens to be 15%, and thus you are indifferent between a 10% rate of return, with no leverage, and a 15% rate of return with 50% leverage on your project. This theory is called the Miller-Modigliani debt equivalence theory, and won them the Nobel Prize some 50 years ago.

Okay, now to the perpetuity. A perpetuity is a perpetual stream of cash flow. That's not so silly as it sounds: a bond with principal constantly reinvested is the same thing. You can think of your salary as a perpetuity... how much money do you need, today, to quit your job and never work again, enjoying the same lifestyle that you do now? You'd need the present value of your salary perpetuity.

Calculating present values of perpetuities is dead easy. It's just the cash flow divided by the discount rate. So I took Avi's $3 million/year from subsidized financing, subtracted 33% for income tax ($2 million/y after tax) and divided by 0.1 (10%) to get a present value of $20 million. Voila.

If you assume that the stadium project has a net present value of zero; ie, if the $300 million investment earns you a stream of cash flows that's worth $300 million, then $20 million is a pretty big nut that could well affect your decision to take on the project.

Why do I assume that the net present value of the stadium is zero? Again, this isn't a completely stupid assumption: if the stadium were economic on its own merits, then it wouldn't need subsidized financing because somebody would build it for a profit. QED.

Just to be clear, I'm responding to Andy. Avi got his post in as I was typing mine. And I agree with his points on hidden financing. That's why the risk profile is so important: who takes construction overrun risk, for example? The city, of course, unless we want to be stuck with a hole in the ground.

I'm a little bit more charitable on the subject of infrastructure; an LRT access, say, is a scalable public good that shouldn't be paid for 100% by the Oilers. General infrastructure spending increases growth capacity and GDP, while stadiums are just cathedrals. But there are grey areas.

"There'd be a good post in simply listing all the creative ways we can think of that the arena could get public support without it being a blatant pay-for-the-arena investment."

Thank you.

I understand Andy's trepidation, but somehow I get the sense that its far easier to push something aside in this town than it is to try and figure out a way to make it work. Well I suppose its the same everywhere. But still, the negativity in this city floors me sometimes. Maybe I've been gone too long. I dunno.